Pages

Friday, February 24, 2012

Second LTRO reveals market bias toward dollar bearishness

Back in December when the ECB first announced the 489 bln euro LTRO the euro currency rallied.

Now the ECB is out a second LTRO in the amount of 470 bln euro and the euro is once again rallying.

I have to admit, it's odd to see the euro's strength in the face of all this "money printing." The ECB lends $600 bln in ONE DAY and the euro goes up. When the Fed even hints at doing QE or any other form of monetary policy that adds to its balance sheet, investors are all over the dollar, selling it wildly. The last round of quantitative easing played out over six or eight months and the dollar got crushed. The ECB does it in one day and it's bullish for the euro. Go figure?

To me, this behavior exposes what I believe to be an inherent and irrational, negative bias toward the dollar. People want to sell it for any reason. Their arguments against the dollar (e.g. QE is "money printing") are not only wrong, but applied solely to the dollar and no other currency. If some other central bank or fiscal authority does the exact same thing, these very same investors are are either ambivalent or rationalize it in a way that allows them to take the opposite view.

"The ECB is printing 500 bln euro? Oh, that's bullish."

Sorry, but you can't have it both ways. Something's gotta give. Investors are clearly acting irrationally when they sell one currency for one reason and buy another for exactly the same reason. This type of behavior MUST NECESSARILY lead to a massive loss of money for those operating in this regard, at least eventually.

The problem (for me) is that, as Keynes said, investors can stay irrational longer than I can remain solvent. :(

10 comments:

Mike, I think the thing with the ECB and euro "printing" is the fact that investors are more worried about stability in Europe the most. They didn't expect the ECB to come up with a legit plan to stabilize the system (albeit short term).Thats what LTRO did though, it stabilized the actual "debt crisis" we saw in Europe even though its "money printing".

The thing with the FED/Us $ is that people expect that to happen already. At least that is my reasoning. So they view the "money printing" here as inflationary currency devaluation.

Mike, apart from irrational negativity toward the dollar, could there also be non-market-based bias toward the Euro? For many Europeans, the Euro is not just a currency, it's a cause. It is a symbol of their political unity and of their attempt to build a continental social and economic framework to conquer the historical scourges of division and war that afflicted them for centuries.

When any sort of risk-on starts people starts to sell dollars to buy other assets.

Why buy totally overpriced american stuff when you have cheap stocks, debt or whatever all around the globe (from Japan to Europe).

There is an excess of dollars in the world, accumulated for trade purposes during decades, the dollar when the rest of the economy is increasing activity can only go down.

Unfortunately this is not enough to correct trade imbalances which is the real problem here, because unstable imbalances can't keep going forever and it will end in disaster. As long as the rest of the world is giving 'credit' (in the form of accumulating FX reserves and USD-denominated paper assets) there won't be a fix to this and exchange rates won't stabilize and the dollar will continue to go downhill.

I see two major factors operating. First, the euro is the DM discounted. The issue here is the discount. As long the risk is other countries than Germany dropping out of the euro, the euro will remain relatively strong. If political problems in Germany seem to suggest that Germany may withdraw and go back to the DM, then the situation reverses for the euro.

Secondly, the USD is overvalued as shown by the persistent trade deficit, therefore the bias is down until the trade deficit begins to fall as the dollar reaches a more realistic valuation. Then net exporters start panicking as they look down the throat of Godzilla and start buying dollars like mad to save their economies.

Mike: I don't know. It could be what Warren has been saying, actually. Austerity actually creates a "shortage" of euro. The market is structurally short and that's why it's going up.

Right, the EZ is set up with a deflationary bias. But that doesn't explain why ECB printing is having little effect on perception of the value of the euro, since the idea is to offset that deflationary bias.

Printing money is not what is happening, because govt spending is not boosted (it is slashed). QE / LTRO is just changing liquid instrument (bond or other collateral) to cash / reserve balance. LTRO is perceived bullish because it helps the weaker banks and govts to fund themself (pile up the debt) for some time and therefore postpone the final countdown.